Take care over this Twitter market frenzy

Let’s not be blinded by the glitz and glamour of Twitter and others. Exciting?
Undoubtedly. Sustainable? Doubtful.

Sceptics who thought Twitter's debut would be a repeat of Facebook's disastrous IPO were proved wrongPhoto: Reuters

By Jonnie Goodwin

2:56PM GMT 09 Nov 2013

Nothing sets the news media abuzz like a major consumer technology IPO. This week it was Twitter’s turn to take centre stage, making its long-awaited stock market debut at $26 a share, before closing its first day of trading at almost $45, having rocketed up by 73pc.

For Twitter, like its forebears Facebook, LinkedIn, Groupon and Google, it has been a fascinating road to a flotation. As ever, investors and commentators have been queuing up to cast the IPO as either a slam-dunk investment or a disaster waiting to happen.

Historically, valuations in the technology sector have been a fine balance between extreme risk and seemingly limitless reward. In May 2012, Facebook’s IPO, the most eagerly anticipated of the past decade, initially verged on the catastrophic as investor appetite wobbled in view of the heady pricing. Let us not forget that even then Facebook boasted nearly a billion users worldwide and was profitable.

The private capital markets play by a slightly different set of rules from the often brutal public markets. In the private market we are seeing companies that don’t yet have revenues attaining multi-billion dollar valuations. The primacy of growth for the venture capitalists who define these private markets cannot be underestimated. SnapChat, the mobile picture messaging platform, is rumoured to be valued at $3.6bn (£2.2bn). Pinterest, a digital pinboard, has recently raised more capital, valuing it close to $4bn.

Though neither SnapChat nor Pinterest has started to generate meaningful revenue, investors are betting big on their ability to do so with a growing audience of highly engaged and valuable users. On such bets are fortunes made and lost.

Notably, Twitter, SnapChat and Pinterest are all US-based companies, albeit with substantial global followings. And they appear indicative of a brand of momentum investing that has become very popular in recent years.

This is not, though, the same as the destructive forces that we saw at the beginning of this century. Then, operations without plausible business models were raising vast amounts of capital and failing painfully. Now, digital ubiquity has allowed Twitter to reinvent the notion of “broadcast” – becoming more than simply viable, but extremely valuable to advertisers and consumers alike.

Ironically, perhaps, there seems to be a lot of chatter on Twitter of a bubble emerging. Calling a bubble is always somewhat fraught but it is not difficult to see why some are suggesting that there is one. With a zero-interest-rate environment, investors are forced to seek growth elsewhere – emerging markets for some, disruptive technology for others.

Unsurprisingly then, stock markets are at record highs. And in the private markets, there seems to be a re-emergence of valuations based on non-financial metrics.

For those of us who bear the painful scars of 13 years ago, this feels like history may be starting to repeat itself.

In the UK, despite the generally positive feeling about the recovery that abounds, there is a concern that rising property valuations, especially in London, and increasing consumer credit may be creating a false sense of economic momentum.

My sense is that we are in the midst of a two-speed market: at one end, companies such as Powa Technologies, a UK-based mobile payments business, just raised the largest ever Series A investment round of $76m.

And at the other, numerous companies with strong fundamentals in less dynamic segments of the digital universe are being funded far less extravagantly, with investors demanding evidence of traction before committing more capital at ever higher valuations.

What is powering the frothier of these two markets? Mainly, the insatiable appetite of investors to back what one investor referred to as “unicorns”: that is, the outliers – the fewer than 0.1pc of companies that can sustain a billion-dollar-plus valuation on the public equity markets.

In other words, these so-called unicorns are as rare as their mythical counterparts. The fear is, of course, that such a pursuit creates a universal sentiment that is self-fulfilling rather than based on fundamentals and economics.

Private company valuations are difficult to verify as companies usually need to fund growth by raising capital from a relatively small investment community. This can and does lead to groupthink, a dangerous mind-set that happens all too often. For private investors, liquidity is crucial but not always achievable.

Public equity markets, though, are often more exacting than the private markets.

This type of investor, seeking to generate a return through investing in mutual funds or directly as a retail investor, usually has a limited appetite for hyper-growth. Profits and dividends are the yardsticks by which the man on the street measures the success of his investments.

Compared with New York, London rarely sees these massive technology flotations.

The risk appetite is not really there. That’s not a bad thing. What we must do, though, is create the conditions for some of our own digital stars to be able to seek liquidity on the public market.

The Future Fifty project of Britain’s most promising tech companies represents some good progress. Ensuring that our home-grown entrepreneurs can have the ambition of an IPO is essential.

All of this leaves us in uncertain territory. There remains unprecedented opportunity offered by the extraordinary increase in connectivity that we have witnessed in recent years. And where there is opportunity, there must also be risk.

New business models are being developed almost hourly. Most will never get to where Twitter has.

There is no problem with that. It is, in fact, a fundamental economic condition.

More than 1,000 US start-ups which received seed funding are set to be “orphaned” this year, losing investors more than a $1bn. It’s not fun for brave founders or risk-inclined investors but it does represent healthy natural selection at work.

No doubt some will call Twitter’s IPO as the top of the market. Only history will be able to confirm this assessment.

My hope, though, is that some of this momentum investing will slow.

A two-speed market suggests too much irrationality and, as we have seen in the past, this rarely has positive consequences. Keep an eye on the numerous companies which are the subjects of the hype. The so-called unicorns gained their moniker for a reason.

Most entrepreneurs build their businesses patiently, trying their best to develop income that is sustainable over the long term. And these are the people on whom a long-term economic recovery can be built. Let’s not be blinded by the glitz and glamour of Twitter and others. Exciting? Undoubtedly. Sustainable? Doubtful.

Jonnie Goodwin is founder of Lepe Partners and a member of the advisory panel for the Future Fifty project